One of the best mutual funds isn’t afraid of federal regulators breaking up Google-parent Alphabet (GOOGL), or of China’s military threat against a major chipmaker, or of Tesla‘s (TSLA) recent price pullback.
The fund is the $8.3 billion Putnam Growth Opportunities Fund (POGAX). And the reason for its courage in the face of each of those risks is coolheaded logic.
Growth Opportunities co-managers Richard Bodzy and Greg McCullough stick by those stocks — like all of their holdings — because they fit the fund’s investment strategy. Crucially, they are a breed of marathon champions.
Not only is their earnings growth above average. That growth is durable.
Best Mutual Funds: Interest In Tesla, Taiwan Semiconductor And Disney
Why does durability matter? Because rival investors are more likely to misprice stocks’ growth the further out in time they’re trying to forecast that growth.
It also includes Taiwan Semiconductor (TSM), arguably the world’s most important contract chipmaker.
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And the portfolio includes economic recovery plays Walt Disney (DIS), Airbnb (ABNB) and DraftKings (DKNG). Unlike many money managers, Bodzy and McCullough don’t claim to ignore macro factors as they execute their investment strategy.
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Moves like those have worked well for the fund. The fund is a 2021 IBD Best Mutual Funds Awards winner. It won in three categories. In each, it topped the S&P 500 in calendar 2020 as well as over the prior three, five and 10 years on an average-annual-return basis.
In fact, its 2020 return more than doubled the S&P 500’s, 38.41% vs. 18.4%.
Bodzy, whose 40th birthday is nearing, and McCullough, whose 43rd birthday is coming up, spoke with IBD about their investment approaches while in South Carolina and New Hampshire, respectively, away from their Boston offices.
How This Fund Seeks Leading Stocks
IBD: What is this fund’s investment strategy, in a nutshell?
Richard Bodzy: We invest in companies with above-market growth, with durations. And typically these companies are aided by a multiyear secular theme.
IBD: Does “duration” mean they must be capable of sustaining their growth long-term?
Bodzy: We’re looking for companies that can grow at above-market rates, and do so with a multiyear time horizon.
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IBD: Since you don’t seek the very fastest growers, what’s the rationale for seeking that long-term growth?
Greg McCullough: The market from time to time underestimates the growth capability of a business in the short term. But it underestimates a company’s ability to grow over a long period more often.
IBD: Which creates buying opportunities for you?
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IBD: Which secular themes do you play?
McCullough: There are 11. There’s 5G connectivity and the Internet of Things, Amazon’s influence, autonomous and electric vehicles, and cloud infrastructure and software.
The fifth one is “controlled distribution,” which refers to the increasing number of retail-brand owners that sell products through their own stores or websites. They have few if any third-party sales. They rarely have markdowns. The advantage is that it allows businesses to better control inventory, pricing, promotion and brand presentation. It also leads to a better relationship with end customers.
The sixth is digital marketing. That’s related to others, like e-commerce and digital payment processing.
Then there is the humanization of pets. Another is the time that people spend in front of computer and smartphone screens. Personalized medicine is another. Finally, effects of the Covid-19 virus.
Stocks This Fund Likes In An Economic Rebound
IBD: How is the fund playing the economic rebound that seems imminent?
Bodzy: We’re staying within process and investing in some of the best growth companies in the world. Over an appreciable time horizon, call it three plus years, growth companies are where investors will want to be.
But on the margin, an economic reopening will likely occur throughout 2021. As a result, most recent names added to the fund have not only fit our criteria, but also have a benefit from an economic reopening.
Why One Of The Best Mutual Funds Likes Disney
IBD: Such as?
Bodzy: Disney is a name that we bought in the second half of 2020. Over 35% of their EBIT, earnings before interest and taxes from the theme parks, are temporarily underearning their potential.
We think they’ll bounce back as the economy reopens. We also like it for the Disney+ asset, which we think can have over 300 million subscribers much like Netflix (NFLX) over a few years. In addition, it can be cash flow positive in a couple of years as well.
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IBD: What’s another recent rebound play?
Bodzy: We participated in Airbnb’s initial public offering in 2020. We’ve been there the whole time and actually made our stake larger. They’re the industry leader in an area that should really benefit from hybrid work environments and workplace flexibility and pent-up demand to travel, which should also help Disney.
Their market-share lead is growing at a fast pace. We think profitability will be very meaningful in a couple years.
IBD: What’s a third stock that should benefit from the public being able to resume normal activities?
Bodzy: DraftKings is a pure play on U.S. sports betting legalization across most of the country in coming years. They have a tremendous platform and meaningful market share. And obviously you need fans being engaged to have more wagering. We think that’ll heighten as the economy reopens.
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IBD: Are you reacting to the prospect of heightened regulation of Big Tech platforms?
McCullough: It’s fairly clear from the president’s comments and folks he’s putting in place that technology-sector regulation will be a focus of the administration. We’re underweight the FAANG stocks and some other big megacap tech companies. We’ve been underweight in the FAANG complex for a long period. That underweight has gotten bigger in recent months.
IBD: What are your main concerns?
McCullough: Not every megacap tech name has the same risk of regulation. We size positions accordingly.
Microsoft has been reinvented under CEO Satya Nadella. They’re far more open to partnerships. That’s what’s driving growth. They sit at the crossroads of lots of megatrends within technology.
Azure, its cloud business, is the crown jewel. It’s a $30 billion business that’s growing at nearly 50% a year. We expect that to continue well into the future. Microsoft generates $50 billion of free cash flow a year. They’re compounding earnings and free cash flow in the double digits.
Does One Of The Best Mutual Funds Expect Regulators To Break Up Alphabet?
IBD: I imagine that Alphabet faces greater regulatory risk. The worst-case scenario is breakup. Do you think it faces that?
Bodzy: Google’s compilation of consumer data and dominant market position do put the company at greater risk of regulation than many businesses and even many other large-cap tech companies such as Microsoft. But we do not, however, believe the company is at serious risk of being broken up. We think it would be very difficult to disentangle the parts of Alphabet in a breakup, and we’re not sure that doing so would benefit consumers.
IBD: Name a key driver for Alphabet that many people might not fully appreciate?
McCullough: Alphabet’s Waymo (Alphabet’s autonomous driving technology development company) and Verily (its life-sciences arm) will likely become disruptors over the long-term.
They’re like owning call options on Alphabet. They’re call options in the sense that they represent a very small part of Alphabet’s overall revenue and market value today. But they are disruptors in massive markets — automotive transportation and health care — and they could become much larger contributors in the future if they are able to execute on the business plans.
Why One Of The Best Mutual Funds Built Its Tesla Stake
IBD: Tesla’s car production rose in 2020. Revenue from China car sales are way up. The firm says its new electric vehicle factory near Berlin will be trendsetting. Yet Tesla share price is off more than 20% since January. Still, you’re bullish. Why?
Bodzy: Our fundamental view of Tesla hasn’t changed. We made our initial purchase in early 2020. We increased our position substantially in the second half.
Tesla is a potential beneficiary of Biden policies. The company has a strong brand and is differentiated from other auto manufacturers. The bet here is that over time the business scales up and battery costs are reduced. Ultimately, there can be meaningful profitability. We’ve already seen them achieve free-cash-flow positive results. Over the long term, profitability can be enhanced in a significant way.
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IBD: PayPal (PYPL) of course is at the crux of your e-commerce and digital payments theme. What gives it legs?
McCullough: We expect high teens revenue growth and 20% plus earnings per share growth over the next three to five years.
It has further upside potential from its ability to monetize Venmo (its peer-to-peer payment platform), as well as from its underleveraged balance sheet and from initiatives into buy-now-pay-later arrangements with partners.
Is One Of The Best Mutual Funds Afraid Of China?
IBD: Tensions are rising between the U.S. and China. And China keeps threatening Taiwan, where the company Taiwan Semiconductor is based. Given the global computer chip shortage, are you concerned about a possible Chinese invasion of Taiwan for broad political reasons, which incidentally would leave the world’s leading semiconductor manufacturer in the hands of China?
McCullough: TSM has established itself as the dominant semiconductor outsourcer. It is a critical partner of companies like Apple (AAPL), Qualcomm (QCOM), Broadcom (AVGO) and Nvidia (NVDA). The world couldn’t function without TSM chips.
The company is doing what we consider prudent by expanding its manufacturing footprint, including a new factory in Arizona.
TSM chips increasingly are part of industrial products and applications. We expect that criticality to be a big driver of growth into the future.
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IBD: Dynatrace (DT) makes computer network monitoring tools. Is its key driver rising demand for those tools as companies move their apps to the cloud?
Bodzy: We’ve owned Dynatrace since its IPO in July 2019. We expect the company to grow its top line 25% to 35% for the next four years. You’re right, Dynatrace is a company that’s been coming out the other side of the pandemic stronger, and more competitively advantaged.
And what’s even more attractive, the company is able to deliver this revenue growth, again, with free cash flow margins well above 25%, due to a highly efficient operating model. Its developer base allows a lower percentage of research and development relative to peers for structurally higher margins.
And we think Dynatrace is best positioned to compete at the enterprise level. And it’s going to continue to take share from legacy on premise solutions.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
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